Question

Majestic Homes stock traditionally provides an 8% rate of return.The company just paid a $2 a year dividend which is expected to increase by 5% per year.If you are planning on buying 1,000 shares of this stock next year,how much should you expect to pay per share if the market rate of return for this type of security is 9% at the time of your purchase?

A) $48.60
B) $52.50
C) $55.13
D) $57.89
E) $70.00

Answer 1

C) $55.13

Step-by-step explanation:

Dividend in one year = Current dividend * (1 + growth rate)

Dividend in one year = $2 * (1+0.05)

Dividend in one year = $2 * 1.05

Dividend in one year = $2.1

Price in one year = Recent dividend * (1+growth rate) / (cost of equity - growth rate)

Price in one year = $2.1 * (1+0.05) / (0.09 - 0.05)

Price in one year = $2.1 * 1.05 / 0.04

Price in one year = $2.205 / 0.04

Price in one year = $55.125

Price in one year = $55.13